Friday, September 16, 2016

Introduction to Economics: The concept of opportunity cost

The concept of
scarcity tells us that we cannot have everything we want because resources are
scarce.

The concept of
opportunity cost tells us that there is a trade off. The opportunity cost is the
giving up of next best alternative use for a resource.

For example, we
have a hundred dollars. We can invest the hundred dollars in mutual fund. We
can use the hundred dollars to buy grocery. We can donate the hundred dollars
to charity. We can use the hundred dollars in many other ways.

When we narrow
down the use of the hundred dollars to two choices, we make it easier to make a
decision. We can choose to invest the dollars in mutual fund or buy grocery.
Let us assume that we use the hundred dollars to buy grocery. The opportunity
cost of the grocery is mutual fund investment.

Once we use the
hundred dollars to buy grocery, we forgo the chance of investing in mutual
fund.

The concept of
opportunity cost is the central theme of the study of Economics.

We see people
make decisions every day. We see the governments make decision every day. Every
decision has an opportunity cost.

When a student
has to choose between work and attend the lecture in the afternoon, he is
evaluating the opportunity cost. Since he cannot work part time and attend the
lecture in the same afternoon, he has to make a choice. Let us assume that he
chooses to work instead of class. The opportunity cost of work is the lecture.

Another student
may make a different choice. The opportunity cost is different. The opportunity
cost will depend on what we have to give up by our decision. The opportunity
cost differs from person to person.

Some people
choose to sleep and miss work. Ultimately, the opportunity cost of sleeping more
is the job. That is a very high cost to pay for a few hours of sleep.

In some cases,
the opportunity cost is computed mathematically. When you have two job offers,
you can compute the opportunity cost in the monetary sense. Let us assume that
company A offers you a salary of $2,000. Your total transportation expenses for
going to work costs $200. Company B offers you a salary of $1,900. You can walk
to work, and save time and money on travelling. It is not that hard to make a
choice when you can compute the opportunity cost mathematically.

On a national
level, the opportunity cost is higher. When the government decides on land use,
it has to consider the opportunity cost. No government will allocate a piece of
land for farming in the prime area of the city. It is stupid to let farming
takes place in the most expensive land in the country.

The concept of
opportunity cost is the central theme of Economics and Finance. The concept of
opportunity cost helps us to improve decision-making skill. Do ask yourself:
what is the opportunity cost of making a choice?